Welcome to the holiday season! Plans are taking shape. Decorations are going up. And many retailers, economists and investors have their ears cocked, eagerly awaiting the sound of cash registers opening from Black Friday, Cyber Monday and beyond.
The holidays are about more than shopping, of course. But how people spend during the holiday season can tell us a lot about the state of our economy. The holidays are also of paramount importance to the nation’s retailers. A good run around the end of the year can be the difference between a profitable year and a money-loser for some merchants.
So where do things stand now? Are there any good tidings for investors?
Overall, consumers are generally in a pretty decent spot. Unemployment is at a historical low after falling for several straight years. Wages have been trending higher. And consumers haven’t been this confident in almost 17 years, according to the Conference Board.
This is important because consumer spending accounts for nearly 70% of U.S. economic output, according to data from the Federal Reserve. An optimistic consumer with more money to spend is good news for the economy.
“Much of the U.S. economy arguably comes down to how the consumer is faring,” says Brad Sorensen, managing director of market and sector analysis for the Schwab Center for Financial Research. “Businesses make hiring and investing decisions based on their expectations of consumer demand. Oil companies sell to consumers who drive cars and to businesses that transport and produce goods for the consumer. Health care companies provide medicine and services to consumers. Materials companies mine for elements that will go into products for consumers. The list goes on and on.”
We’re not firing on all cylinders just yet. Some people are working at jobs for which they are overqualified and wage growth, while edging higher, is still moving pretty slowly. Consumers have also generally been more wary of debt since the financial crisis than they might have been in the past. Still, things are looking solid.
Consider this the economic context as we roll into the holidays. How it will play out for retailers, however, is unclear. Investors who follow the retail sector know the environment for brick-and-mortar shops hasn’t exactly been favorable since online shopping exploded. The news has been counting the toll with dire headlines about big retail names closing shops.
“We do think the picture entering the season is a positive one,” Brad says. “For investors, the question becomes: Does the rosy picture for consumers mean you should run out and buy retailers? At this point, we would say no.”
Overall, retailers do expect shoppers to open their wallets a little wider this year. For example, the National Retail Federation has said it expects holiday shoppers to spend between 3.6% and 4% more in November and December this year than they did last year. And the calendar this year works in shoppers’ favor: There are 32 days between Thanksgiving and Christmas this year, the second largest number of days possible between the two holidays. And Christmas falls on a Monday, giving shoppers one last weekend to ring the register.
However, holiday spending is also changing in ways that make it difficult to paint the entire retail industry with the same brush. Surveys by Deloitte, for example, found that for the first time, respondents said they planned to spend more than half of their holiday shopping budget online this year.
Perhaps more concerning for retailers is that roughly a quarter of the respondents said they preferred to direct their holiday gift dollars toward experiences or travel, rather than the sort of physical gifts you could stuff in a stocking.
Clues for investors
Still, there may be opportunities out there for the investors willing to look past the headlines. Although Census Bureau data show department store sales have been dropping, while online sales have grown, the trends may be converging, suggesting that while the adjustment has been difficult, traditional and online retailers could be getting closer to a kind of equilibrium.
Even the store closures we’ve seen have been more than outpaced by store openings this year, according to market researcher IHL Group. Many of the new openings have been discount shops and convenience stores, while the closures have been concentrated among department stores and specialty chains focused on things like electronics.
“We believe some of these closures are actually helping to ‘right size’ a retail industry that had been plagued by overcapacity among poor performers,” Brad says. “Ultimately, this sorting out of shops will help those retailers that do survive.”
And shoppers’ apparent preference for experiences could reshape in-store shopping in ways that make visiting a shop something of an event. Think of the way shoppers will wait in line and pay a premium price for a handmade pour-over coffee, rather than brew a pot of drip coffee at home.
“Sentiment toward the group is terrible, but for those wanting to wade into a group that has been beaten up lately, we suggest looking at retailers’ stocks as if you’re looking for an overlooked treasure in one of their stores,” he adds. “There are certainly risks, as we’ve seen, and due diligence is required as this will likely be some retailers’ last holiday season.”
“But we believe there are some gems to be had by investors that are willing to do the appropriate amount of digging and can stomach the risk.”
Again, the overall economic environment should be considered a positive for retailers and the consumer discretionary sector more broadly, but tough competition and the changing nature of shopping do pose challenges. At the end of the day, a diversified portfolio should include some exposure to retail, but it’s definitely worthwhile to be selective.